Budgeting Marketplaces Management
Business organisations compete in highly evolving and changing marketplaces. In order to be ahead, or at least to survive these businesses develop, sustain, and gain competitive advantage. Companies continually look within and outside their organisations for opportunities to exploit for competitive advantages. These companies use budgeting as one method to sustain the competitive advantages they gained from their internal processes.
However, critiques of the traditional budgeting method and process have said that it is no longer valid for the same highly evolving and changing marketplaces. These critiques have suggested alternative formats: better and beyond budgeting. This paper aims to evaluate the merits of these alternatives. But before I go on, I will discuss traditional budgeting first.
Traditional Budgeting
Budgeting comes largely into play in the planning function of management. The five basic management functions are planning, leading, organizing, controlling, and staffing. Anthony, Hawkins and Merchant defined budgeting as “the process of planning the overall activities of the organisation for a specified period of time, usually a year” (2003, p. 4).
The traditional budgeting process has grown so complex that management and the rest of the organisation need to spend months preparing their budget. This means that “[many] companies are spending more time on budgeting and less on strategy” (Hope & Fraser, 2001, p. 22). However, to some extent traditional budgeting is effective, and has helped companies achieve some of their goals and objectives.
In spite of the growing dissatisfaction on traditional budgeting, it does serve several purposes:
- “An aid in making and coordinating short-range plans.
- A device for communicating these plans to the various responsibility center managers.
- A way of motivating managers to achieve their goals.
- A benchmark for controlling ongoing activities.
- A basis for evaluating the performance of responsibility centers and their managers.
- A means of educating managers” (Anthony, Hawkins & Merchant, 2003, pp. 774-775).
Some argues that it is because of these multiple purposes that traditional budgeting has been disappointing. Rather than serving as a coordinating, communicating, and motivating tool, budgeting has became a farce: managers knowingly under budget their activities for easier achievement of such budget; and employees work around budgets, say, by deferring major maintenance and repairs the next year if such activities were not budgeted this year.
From the basic definition of budgeting, one thinks that perhaps the traditional budgeting has passed its time. Why so? Budgeting, as Anthony, Hawkins and Merchant said, is for a specified period of time, and hence it must be based on numerous assumptions about that specific period of time. The business environment today is characterised by chaos; one can never be sure to a certain degree what will happen next. As such the assumptions that traditional budgeting is based on continually change rendering the budget itself meaningless, and hence useless. Even John Fanning of KPMG Management Consulting said as early as 1997 that “[the] traditional budgeting method continues to be financially oriented and functionally-based, despite the changes which have affected businesses over the last two decades” (Management Services, 1997, p. 6).
The following parts of this paper will evaluate the merits of the alternatives to traditional budgeting. In the end, I will recommend what method an organisation must adopt. Truly traditional budgeting is under siege (Babbini, 1999).
Better Budgeting Methods
John Williamssummarised the “most perplexing [realisations] associated with budgeting systems” (1981, p. 75). He mentioned that the inherent design of traditional budgeting makes it difficult for any single budgeting process to “simultaneously provide continuity and change, rigidity and flexibility, consistency and adaptability, clarity of purpose and multiple perspectives, stability and innovation, or accountability and experimental [behaviour]” (Williams, 1981, p. 75).These are several of the reasons why the better budgeting concept emerged. Activity based budgeting addresses rigidity and flexibility, and continuity and change at the same time. Whereas rolling budgets
Activity Based Budgeting
Activity-based budgeting is closely associated to zero-based budgeting in that it also involves the “zero-base reviews for all programs as part of the annual budgeting process” (Anthony, Hawkins & Merchant, 2003, p. 773). Activity-based budgeting requires businesses to set budgets for each activity based on expected service level, and volume (Anthony, Hawkins & Merchant, 2003, p. 773). An activity is used to describe a unit of work, or a job with a specific objective. This better budgeting approach, like the others - rolling and zero-based budgeting, still exhibits the pitfalls of traditional budgeting: “too time consuming and costly” (McNally, 2002, p. 10).
However, since activity based budgeting “involves planning and controlling” (McNally, 2002, p. 10) of only value-adding activities and processes, companies using this approach can save costs. Champions of this approach claim that “cost savings is between 10 and 20%” (McNally, 2002, p. 10).
Rolling Budgets
The ever-changing view of the future had forced managers and business organisations to look at their assumptions basic to traditional budgeting. This insight led to the “use of rolling of rolling forecasts (Hope & Fraser, 2003, p. 112). Rolling budgets result from dropping the budget amounts for the quarter just ended, revising the budget of the three remaining quarters, and adding the budget for the fourth succeeding quarter to effectively have a one-year budget (Anthony, Hawkins & Merchant, 2003, p. 781).
Although this approach promises more accurate forecasts, it does lead to higher budgeting costs because of the frequency of forecasting (McNally, 2002, p. 10).
Zero Base Budgeting
On the other hand, zero-based budgeting “involves the preparation of multiple decision packages with varied service levels, thereby leaving the choice of service levels variable until later in the resource allocation process” (Anthony, Hawkins & Merchant, 2003, p. 773). In other words, this approach “requires expenditures to be re-justified during each budgeting cycle” (McNally, 2002, p. 10): companies start each budget cycle from scratch instead of adjusting this year's budget for changes in basic assumptions. Thus zero-based budgeting is very time consuming.
Having said all that, Robert McNally added two better budgeting approaches: value based management, and profit planning. Value based management “requires that all expenditures plans should be evaluated as project appraisals and assessed in terms of the shareholder value they can create” (McNally, 2002, p. 10). After all, the organisation's goal is wealth maximisation for its shareholders. On the other hand, profit planning is the planning of “future cash flows of profit centers by assessing whether a unit generates sufficient cash, creates economic value and attracts sufficient financial resources for investment” (McNally, 2002, pp. 10-11).
Beyond Budgeting Approach
Beyond budgeting is the concept to totally abandon annual budget for organisations to be spared from the flaws of both traditional and better budgeting processes. The research on this alternative to traditional budgeting was a result of the growing dissatisfaction with the budgeting model; one survey found out that 88 percent of respondents were dissatisfied (Hope a& Fraser, 2001, p. 22). Two concepts about the beyond budgeting approach emerged: devolution or beyond budgeting, and strategic performance management.McNally concluded that a more efficient and effective planning and budgeting process results in greater shareholder value (2002, p. 11). This is from an improved management, and the ability to manage market perceptions.
Devolution: Beyond Budgeting
The devolution or beyond budgeting “entails a shift n numbers to one based on people” (Hope & Fraser, 2001, p. 23). The traditional budgeting revolves around financial performance, and financially measured activities. This results to exclusion of other, perhaps even more important, business focus; beyond budgeting aims to solve all this.
To support this concept, twelve general principles were developed by the Beyond Budgeting Round Table. These principles are governance, performance responsibility, delegation, structure, co-ordination, leadership, goal setting, strategy process, anticipatory management, resource management, measurement and control, and motivation and rewards (Hope and Fraser, 2001, pp. 22-23). For a more detailed discussion of these principles, please see Hope and Fraser (2001).
Strategic Performance Management
Strategic performance management and devolution are closely related. This concept of beyond budgeting “transcends the limitations of traditional budgeting by replacing fixed financial targets with targets based on key performance indicators” (McVay & Cooke, 2006, p. 100). The authors further said that “[once] traditional budgeting is eliminated, an [organisation's] performance is no longer viewed against the backdrop of a set of fixed financial targets developed for a one-year period (2006, p. 101). KPIs or key performance indicators include strategic performance. As such a strategic performance management is important.
The main point in performance management is to worker promote empowerment, flexibility and knowledge-sharing which are hoped to help the organisation achieve its goals and objectives more effectively and efficiently (Brown & Atkinson, 2001, p. 138-139).
Appraisal
I believe that perhaps the reason why traditional budgeting lost its effectiveness is that managers and organisations focused too much on the process rather than its objectives. Let's go back to Anthony, Hawkins, and Merchant's definition of budgeting. It is merely a planning tool, and NOT a controlling tool. But what happened was that organisations became controlled by the numbers written in their budgets. This resulted to managers working around budgets, which further defeated the control mechanism the budget was eventually used for.
Also, given the very fast changing business environment today, traditional budgeting further lost its attractiveness and usefulness. Business organisations and their managers need to spend more time developing and implementing strategies to develop, sustain, and gain competitive advantages rather than pushing pencils for next year's budget, which will eventually be worked around on anyway. As such the arguments for better and beyond budgeting deserve serious consideration (Libby, & Lindsay, 2003).
From my discussions on better and beyond budgeting, I say that for business organisations to overcome the flaws inherent to the design of traditional budgeting it is now about time to adopt beyond budgeting approach. However, beyond budgeting is much more than just adopting its concepts; it requires a paradigm shift within the organization - a change that its structure and culture might not be prepared to accept. Bunce and Fraser emphasised the change of organisational philosophy (1997, p. 32). Perhaps this change is much easier for everyone to grasp because for so long organizations have been operating in an environment characterized with “unpredictable change” (Colman, 2003, p. 3).
Let me end by a quotation from Peter Clarke: “Any technique of management reaches maturity when, after its earlier mistakes have antagonised human beings sufficiently, it emerges with a new outlook and practice in harmony with the basic motivations of people” (2004, p. 26). Budgeting is going through this process. Few decades ago, one Gregory Nolan wrote about the certainty of the end of traditional budgeting (2005), and although numerous are still practicing traditional budgeting, these companies are increasingly becoming critical.
References
Anthony, R., Hawkins, D. & Merchant, K. (2003). Accounting Texts and Cases (11th ed.). New York: McGraw-Hill.
Babbini, C. Reality check: Is traditional budgeting under siege. CMA Management, 73(9), pp. 52-55.
bbrt.org. (2006). About Beyond Budgeting - Concepts. http://bbrt.org.
Brown, J. & Atkinson, H. Budgeting in the information age: a fresh approach. International Journal of Contemporary Hospitality Management, 13(3), pp. 136-143.
Bunce, P. & Fraser, R. Beyond Budgeting. Charter, 68(5), p. 32.
Clarke. P. (2004). The Budgeting Process. Accountancy Ireland, 36(5), pp. 26-27.
Colman, R. (2003). Handle with care. CMA Management, 77(1), p. 3.
Hope, J. & Fraser, R. (2003). Who Needs Budgets. Harvard Business Review, Feb., 108-115.
Hope, J. & Fraser, R. (2001). Figures of Hate. Financial Management, Feb., 22-25.
Libby, T. & Lindsay, R. (2003). Part two: Budgeting - an unnecessary evil: How the BBRT envisions a world. CMA Management, 77(2), pp. 28-31.
Management Services. (1997). Companies ‘straight-jacketed' by traditional annual budgets, say KPMG Management Consulting. Management Services, 41(12), p. 6.
McNally, R. (2002). The annual budgeting process. Accountancy Ireland, 34(1), p. 10-12.
McVay, G. & Cooke, D. (2006). beyond budgeting in an IDS the Park Nicollet experience. Healthcare Financial Management, 60 (10), 100-106.
Nolan, G. (2005). The End of Traditional Budgeting. Journal of Performance Management, 18(1), pp. 27-39.
Williams, J. (1981). Designing a Budgeting System with Planned Confusion. California Management Review, 24 (2), 75-85.
We provide a professional essay writing service that thousands of our customers use as an effective way of improving their grades, improving their research and saving them lots of time.
